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Reinsurance and rag dolls

Dear Friend,

The latest news from the coal face of the Florida Cat renewals is that this is the hardest market since 1993. Or to put it in IPC’s terms, it is the FIRST hard Cat market since 1993!

Admittedly IPC’s definition of a proper hard market is super tough — they only call a market hard when some risks go unplaced no matter what price they are offering.

But what kind of a fool market is one that leaves desperate customers unattended?

Underwriters constantly moan that dastardly brokers always exploit their competitive instincts to make sure they leave money on the table, even in the hardest of markets.

But they are forgetting that a failure to supply is the worst way of leaving money on the table of all.

Surely as long as the business is fundamentally sound and is going to make you good money, you should move heaven and earth to get it done.

Everyone in business knows that if you have a product that costs you a dollar it is much better to sell 20 units for $1.50 than only two at $3.

If I were running a rag doll business and demand for my product was such that I had run out of stock and had customers forming an orderly line around the block just to sign up on the waiting list for delivery, despite my having increased my prices more than once, I would get down to my bankers and ask for the funds to help me ramp up production.

It would certainly not be the cue to shut the factory and lay off the workers!

Yet this is what the market is saying to the customer when it fails to meet demand. It is also another way of admitting that it doesn’t actually know what it is doing.

Have you spotted the problem? Catastrophe Reinsurance is not like a cabbage patch doll. The unit cost of a rag doll are easy to calculate as it depends on labour, transport and the price of textiles, but there is no such thing as correct price in reinsurance because no-one ever knows what the true net cost of the product is. The price is theoretical and is shaped by human judgement — and humans are subject to moodswings.

In fact in the financial world the average human’s sentiment is tempered by relatively short periods in the recent past. For example in real estate markets, it takes less than three years of prices rising consistently for people in large numbers to start to believe that house prices always go up.

Over here, as in most western economies, the global monetary accommodation and explosive credit expansion of the last five years has fed into very strong house-price inflation — but mention to anyone in the UK that house prices have undergone regular five- or six-year downward price slumps over the last 50 years and you will be met but howls of disbelief and derision. And this despite the fact that for five years as recently as the mid-nineties the only talk here was of a housing crisis, mortgage defaults and house repossessions!

The lesson is that events erase memories.

Right now if you can’t get cover for some risks at any price, it is because the market has talked itself into avoiding certain areas instead of trying to charge the right price for the right job.

This is because a battered market has talked itself into expecting another appalling hurricane season with multiple US landfalls as a certainty. Thus many players would rather write business that has a bigger chance of losing them money for the sake of diversity. How foolish is that?

So come on down — don’t keep your customers waiting too long.

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